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Investment Overview for Expedia (NASDAQ:EXPE)

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Focus On Growth

According to Expedia's new CEO Mark Okerstrom, the company will focus on strategically important acquisition targets. However, its main aim will be to grow organically through the in-house brands including Hotels.com, Expedia, and HomeAway. The new Expedia Chief wants to see the company as the number one online travel agency in the world.

The company added 40,000 properties to its core global lodging platform in the third quarter, bringing the total property count to around 595,000 (excluding HomeAway), 46% higher compared to last year. It also integrated 100,000 additional HomeAway listings onto its platform, taking the total to 895,000 properties in its core portfolio.

Moreover, Expedia recently acquired Pillow and ApartmentJet with the focus to deploy its capital strategically to enhance its shareholder returns. The deal will include the addition of unique software platforms which will lay the foundation for HomeAway and Expedia Group's urban expansion efforts in the coming years.

HomeAway's Strong Performance

HomeAway continued to deliver solid results, with 24% growth in its 3Q'18 gross bookings and 35% increase in its revenue. It posted adjusted EBITDA of $209 million, 66% higher on a year-on-year basis.

With HomeAway's transition to an e-commerce business taking shape, longer booking windows and a high concentration of stayed room nights are likely to drive its top-line growth in the coming quarters. Despite the seasonality factor, HomeAway is expected to drive healthy top-line and bottom-line growth for Expedia.

Trivago's Turnaround

Surprisingly, Trivago delivered strong 3Q'18 results. The company executed well on its strategy of focusing on profitability, which enabled it to deliver significant improvements in its adjusted EBITDA.

Going forward, the Trivago team will continue to take a more-balanced approach to trade-offs between top-line growth and profitability, with more inclination towards the latter. Consequently, Trivago expects its adjusted EBITDA to improve in the second half of the year.

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Below are the key drivers of Expedia's value that present opportunities for upside or downside to the current Trefis price estimate:

Hotels Bookings

Expedia's Core OTA gross bookings: We currently forecast Expedia's gross bookings increase from $72.7 billion in 2017 to over $114 billion by the end of our forecast period. There can be almost 20% downside to the Trefis price estimate if Expedia's gross booking grow slowly to only $97 billion over our forecast horizon.

EBITDA Margin on Core OTA Bookings: We currently forecast EBITDA Margin from Core OTA Bookings to increase to around 15.7% throughout our forecast period. There would be around 5% upside to the Trefis price estimate if the margins were to increase to around 17% over our forecast period.

Egencia Corporate Travel Services

EBITDA Margin on Egencia Corporate Travel Services: We currently forecast EBITDA Margin for Expedia's Egencia Corporate Travel Services to increase from 13% in 2017 to close to 14% by the end of our forecast period. There would be a marginal upside to the Trefis price estimate if the EBITDA Margins were to grow to 22% by the end of our forecast period.

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Expedia (NASDAQ: EXPE) is the second largest online travel service provider in the world, in terms of revenues. It operates online travel portals such as expedia.com, hotels.com, and hotwire.com, that help connect travelers with travel suppliers, such as hotels, airlines, cruises, and car rental companies.

While serving as a global travel marketplace, Expedia broadly makes money by either (i) acting as a travel agent and charging a commission (known as the processing fee or the booking fee) on every transaction, or by (ii) acting as a merchant and purchasing the travel inventory (air tickets and hotel stays) from the travel providers (airlines and hotels) in bulk at discounted prices and selling the same to the customers at a premium. In addition to this, Expedia sells advertising on its websites, and companies (mostly travel suppliers-hotels and airlines) either pay-per-click or pay a flat fee for the duration of advertising. Trivago, the meta-search engine acquired by Expedia in 2012, is the primary source of advertising revenues for Expedia.

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Expedia's Core OTA business is the primary source of value for the following reason.

Significant Revenue Margins from Core OTA Bookings

Revenue margin earned on OTA bookings is significantly high and has been growing steadily. Gross bookings in 2017 were around $72.7 billion, and the revenue margins (revenue earned by Expedia as a percentage of the size of booking) earned were around 11%. As a result, Expedia's revenue from OTA bookings grew at 15% annually over the past few years.

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The following factors determine the fate of the online travel industry:

Macroeconomic Environment

Due to the discretionary nature of leisure travel, online travel service providers, which earn revenue in the proportion (and as a percentage of) travel bookings, depend entirely on the macroeconomic conditions (employment levels, inflation rates, etc). Corporate travel is, in fact, one of the prime indicators of economic activity and is influenced the most by macroeconomic conditions. During the recessionary times of 2008-2009, both corporate and leisure travel plummeted. Amidst rising unemployment and declining disposable income levels, the consumers cut back on their travel plans first, before making adjustments to other expenses.

Advertising, which constitutes a significant source of revenue for online travel service providers, depends on the level of business activity. Amidst recessionary times, businesses cut back on media and advertising spending and this translates into lower online advertising revenue for travel portals such as expedia.com and priceline.com.

Foreign Exchange

Leisure travelers, unlike corporations, do not hedge themselves against foreign exchange fluctuations. Hence, the spot foreign exchange rates determine the consumer demand for international travel. In times of adverse foreign exchange rate movements (such as a depreciating dollar), international travel becomes dearer and the same hotel booking and air tickets cost more dollars, thereby discouraging travel bookings.

Travel service providers such as Expedia and Priceline, earn revenues from international bookings in foreign currencies, but incur most operating expenses in dollars, and report the earnings in dollars. Thus, adverse foreign exchange movements could erode profits of travel service providers. Since an increasing proportion of bookings are coming from the less penetrated emerging economies, the exposure to foreign exchange is expected to increase in the future.

Fuel Prices

Rising fuel prices has the immediate impact of increasing airfares which discourages travel. This not only impacts air ticket bookings but also negatively impacts hotel bookings and destination services such as car rentals and cruises. Decline in the overall bookings hits travel service providers' revenues.

With rises in fuel prices, airlines are no longer able to offer significant discounts on bulk bookings to travel agents such as Expedia. As a result, the revenue margins earned by travel service providers (under the merchant model) take a hit. The lower revenue margins translate into lower profit margins for the travel service providers.

Significant impact of unforeseen events on travel

Events which are beyond the control of any travel services provider and can critically impact travel, include terrorist attacks, unusual weather patterns, and natural disasters (hurricanes, tsunamis, volcanic eruptions), travel related health concerns (Influenza H1N1, avian bird flue, SARS), political unrest, and other unpredictable events. Unlike other industries, such events have a very significant impact on travel bookings and consequently on the revenues of travel service providers.

Internet Penetration

While the U.S. has over 78% of internet users, the proportion of Europe’s population online is close to 61%, with the internet penetration in Asia being even lower, at 26%.
Hence, the increased internet adoption and rise in e-commerce will favor travel providers such as Expedia and Priceline.

Airline Industry

Fuel expenses constitute the single largest cost head for airlines, making them vulnerable to hikes in crude oil prices. To reduce vulnerability to fuel price volatility, many airlines engage in fuel price hedging.

Demand for flights is highly correlated to the global economic growth. Thus, a decline in economic growth, or recession, reduces demand for flights, impacting passenger traffic for airlines. On the contrary, steady growth in the global or U.S. economy, grows demand for air travel, allowing airlines to raise their air fares, occupancy rates, and profits.

Many airlines are figuring out ways to grow their top lines through ancillary means such as baggage fees, access to onboard WiFi/food/drinks, etc. Accordingly, airlines are investing to enhance their product offerings that include in-flight WiFi and other entertainment options, improved lounge facilities, and extra legroom seats.

During the past decade, low-cost carriers such as Southwest and JetBlue have gained significant market share in the U.S. Looking ahead, we figure these low-cost carriers to continue to grow their market share, as their lower fares attract passenger traffic.

The U.S. airline industry has seen many mergers and acquisitions in the last decade including the five big combinations of US Airways and America West, Delta and Northwest, United and Continental, Southwest and AirTran, and American and US Airways. A more consolidated industry has worked to improve profits of all airlines. Fewer players in the market has made it easier for those remaining airlines to add capacity with restraint. Prior to this consolidation in the airline industry, individual airlines were adding capacity at higher rates in an attempt to grow their market shares. This rapid capacity addition resulted in an oversupply of seats, reducing margin and profits of all carriers. Going forward, we believe as long as airlines add capacity with discipline, the industry will remain profitable overall.

Hotels and Lodging Industry

During the recessionary times of 2008-2009, as travel declined, so did hotel occupancy rates (the proportion of hotel rooms occupied per year). To meet the operating expenses (since the hospitality business has a significantly higher proportion of fixed costs), hotel owners resorted to offering discounts and lower tariffs. This led to a drop in the Average Daily Rate (the average rate per night of hotel booking). Hotels bookings took a hit and adversely impacted the revenues for travel service providers.

At 16.3%, hotel Bookings offer markedly higher revenue margins (revenue earned by the travel service provider as a percentage of the size of booking) compared to air ticket bookings (~2%). Hence, travel service providers make maximum profits from hotel bookings.

The hotels market in Europe and Asia is much more fragmented with smaller, independent lodgings compared to the U.S., where the hotel market is dominated by large hotel chains. Hotel chains are more likely to offer online bookings through their own websites, while online travel agencies such as Expedia are more appealing to small, independent hotels outside the U.S. Travel agencies stand to make higher revenue margins from independent budget hotels under their merchant business model, hence expansion into the hotel markets in Asia and Eastern Europe presents U.S. based online travel service providers with significant growth opportunities.

Competition in the U.S. online travel market remains intense and traditional online travel companies are creating new promotions and consumer value features in an effort to gain a competitive advantage.

In June 2007, Priceline eliminated processing fees for its price-disclosed airline ticket services, and in April 2008, it reduced processing fees for its domestic price-disclosed merchant hotel room service. Starting in March 2009, Expedia and Travelocity also eliminated air booking fees, and in April 2009, Orbitz followed. In April 2009, Expedia and Orbitz reduced booking fees on hotel room reservations. As a result of this, no one player could maintain a price advantage over the others on price-disclosed merchant air tickets and hotel room reservations, and the online travel industry as a whole lost revenues.

In October 2009, Travelocity announced the waiver of its cancellation and change fees for hotel and vacation packages as well as an expanded hotel guarantee, under which consumers who book a hotel room and then find a lower published rate for the same room anytime before the day of check-in are eligible to receive a refund of the difference.

Since consumers are now increasingly looking for bargains and discounts, traffic obtained through online advertising has increased as a percentage of total demand since the same consumer visits several websites before making a purchase decision. This increased shopping behavior has reduced advertising efficiency and effectiveness as traffic obtained through online advertising becomes less likely to result in a purchase on the web site. Therefore, online advertising expenses for the company have increased at a faster rate than gross profit, a trend which is expected to continue in the future.

Threat from Online Search Engines

Large and established internet search engines with substantial resources, and expertise in developing online commerce and facilitating internet traffic, are creating and intend to further create, inroads into online travel, both in the U.S. and internationally.

Google acquired ITA Software, Inc., a major flight information software company, which could allow it to pursue the creation of a new flight search tool which enables users to find flight information on the Internet without using the services of Expedia or Priceline etc. Google has also invested in HomeAway, a vacation home rental service.

Google has also launched a travel “meta-search” site to show searchers specific hotels and rates in addition to text advertisements. Microsoft has launched Bing Travel, a “meta-search” site which searches for airfare and hotel reservations online and predicts the best time to purchase them. “Meta-search” sites leverage their search technology to aggregate travel search results for the searcher’s specific itinerary across supplier, travel agent, and other websites, and in many instances, compete directly with online travel service providers for customers.

How Does Trefis Modelling Work?

How do we get the historical numbers for this chart?

Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.

Who came up with the Trefis forecast for future years?

The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.

How does my dragging the trendline on the chart impact the stock price?

We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.

We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.

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